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Negotiating Strategies

Adding Real Value for the Tenant

I get to brag every now and then.

 

I just wrapped up negotiations for a lease where I represented a residential real estate brokerage office.  We found the ideal building on a high profile corner in West Los Angeles that was right in the middle of their primary “farming” area – exactly where the company wanted to be.  There was only one thing missing and it was a big thing: exterior signage that would promote their brand to a high volume of traffic on the two busy intersecting streets that passed in front of the building. 

 

The building already had two large tenant signs on the exterior walls and the landlord deemed this was their limit.  But there was a small, innocuous address monument sitting in the landscaping on the corner.  It was the perfect place for a monument sign but in the 20 years the building had been standing there, the ownership was never motivated to erect one.   That is, until Aaron Weiner came along, wielding the colossal leverage of a 2,000 square foot tenant.  (Yes, that’s a little sarcasm!)  And so I pressed for an opportunity to create a benefit for my tenant far more valuable than grinding for a little lower rent rate.

I enlisted the support and cooperation of the listing broker.  Together, we convinced the landlord to engage a sign contractor and develop a design.  I demonstrated to the landlord how he could recover 100% of the cost of the sign from the tenants who appeared on it.   When they presented the design to the tenants in the building, the proposition was well received and several positions on the sign went very quickly.  But the landlord was slightly concerned about the two slots that remained.  So I explained how those empty positions on the monument would  serve as a magnet to attract new tenants!  That sealed the deal.

Some of the credit goes to the landlord who was intelligent enough to embrace the benefits of the sign.  But I had the satisfaction of scoring an unlikely victory for my client and creating long term value for the landlord. 

Unfortunately, I was unable to convince the owner to put my name on the sign.  (More sarcasm!)

The Unavoidable Issue Of Tenant Creditworthiness

Recently, I was working with a tenant whose entertainment-based business was doubling year over year.  He needed to move out of his 4,000 square foot space and find something around 12,000 square feet to facilitate contracts that were coming down the pike from major entertainment companies and studios. 

We found the perfect building in the perfect location and lobbed a reasonable offer in to the landlord.  We were making progress negotiating terms but when the landlord looked at the tenant’s financials we hit a snag; well, more than a snag – a brick wall.  The landlord was concerned over the tenant taking on rent that was triple what he was currently paying and demanded a huge security deposit to offset what he perceived as the risk in leasing his building to my client.  The up-front cash demand killed the deal. 

My client was extremely disappointed.  This is understandable but I explained to him that I have successfully navigated negotiations for tenants facing greater challenges:

  • I had a client who had a recent bankruptcy on their record that would have cut off discussions with many landlords.  I coached them to present a story that explained how their recent financial troubles were unrelated to the business that would be operating in the space and paying rent.  We got over the hump and negotiated a very fair deal for them.
  • I had just finished negotiations on a 10 year lease of a surface parking lot in an upscale Westside commercial district for a client who was an immigrant from south Asia and who had just become a citizen of the U.S.  While he had several years of experience in the parking lot management industry, he didn’t have two nickels to rub together.  We got the deal done – with a sophisticated landlord, no less – without providing any financial statements whatsoever.  The tenant did have to pay an enhanced security deposit but I negotiated terms that will get most of it refunded to him after the first couple of years of the lease.

Tenants with less than stellar financials will occasionally encounter a very skittish property owner but there are others out there that will be much more open to leasing to a promising business.  

A good tenant representation broker can help write the story that will end in “happily ever after”.    

Tenant Improvement or Landlord Improvement?

One of the fundamental economic facets of a commercial lease is the value of the tenant improvements that that are constructed for the new tenancy.  Whether it is an office building, shopping center or an industrial property, paying for the construction of needed improvements or upgrades is a major consideration for both the landlord and the tenant.  In the case of a tenant improvement allowance, the landlord contributes a stipulated amount and the tenant pays for any cost overruns.  A good understanding of the logic behind these improvements can go a long way toward getting a little more for the tenant.  The key is to look at the nature of the improvements.  

Sometimes The Real Estate Is Only One Leg Of The Race

When you are negotiating to purchase a business part and parcel to accelerate your growth, expand your business range, or increase your market share, there are two critical facets of a sound economic deal: the valuation of the business and the cost related to the real estate. 

When the real estate is for sale with the business, establishing the intrinsic value of the real estate is more or less a function of two standard appraisal practices: analyzing value by looking at comparative sales, and by looking through the lens of the highest and best use of the property.  

It becomes a bit trickier when the real estate is retained by the seller and leased to the buyer or is leased in the first place.  The rental costs of the real estate have a huge impact on the net income projections of the business and cannot be negotiated separately from the acquisition of the business enterprise.  Doing so puts untenable pressure on the dealings for the second piece and negotiations could breakdown altogether.  The two major financial pieces must be on the table at the same time. 

I am typically involved in the buy side and recommend to my clients that they let the business seller express their preference of whether they want to get the best possible pricing on the business or on the real estate.  Then everyone involved knows what part we will be negotiating and understands how the two are linked together.

Exercise both legs simultaneously or else you will be limping – or worse, hopping – toward your future success.

Ask Correctly and Ye Are Likely To Receive

Even the best businesses run into cash flow problems.  There are often sources of internal capital that are available to cover these dry spells including cash reserves and credit lines.  When those are not available, often the biggest help can come from the landlord the business sends their rent check to every month. 

Inexplicably, most tenants assume the fetal position when dealing with the landlord.  Think of the term – the “lord of the land.”  It’s amazing that this medieval concept has survived to the present day.  In my previous life as a property manager I often dealt with tenants begging for relief and mercy from the landlord.  Such a misguided approach to seeking financial assistance rarely got the tenant what they were asking for or what their business really needed. 

A tenant needs to approach the relationship with their landlord from a modern perspective; that is, two complimentary businesses in a contractual partnership.  When you view things in this light, the request for rent relief becomes a simple business transaction: an investment by the landlord in the tenant’s business.  Think about it: when a business solicits investors for money, they sell the positive prospects for success.  The tenant needs to characterize the trouble they are facing as a temporary setback caused by market conditions or perhaps a business miscalculation on their part.  In any event, their pitch to the landlord needs to emphasize the fact that with some help, the problem can be neutralized or reversed and that the ultimate result will be a stronger tenant who will be better able to fulfill their contract with the landlord.  

This strategy works when you get sound guidance from a good real estate broker and advocate.  I recently coached a client of mine and helped them get $60,000 of rent relief.  In addition to helping them word the request using the proper, positive tone, I advised them to propose repayment terms that would allow them to pay back the balance due ahead of schedule and leave the landlord feeling like they had made an excellent investment. 

Beats begging, doesn’t it?

Search For Answers

I wish I could tell you I have all the answers but I do not.  (Alert the media!)  Grave concerns perceived by my clients show up during lease and purchase negotiations that I cannot resolve with persuasion or market knowledge.  Do you have kids?  Ever notice how your child will take an outsiders advice more seriously than yours?  OK, now we’re on the same page.

When negotiations get into crunch mode and the deal is on the line, the tenant may begin to wonder whether their broker’s advice is offered in their best interests or in the interest of closing a deal and collecting a commission.  That is when I often call in outside experts that can provide facts and perspective that will lead to a wise decision by the tenant that really does support their objectives.  These outside resources include attorneys, accountants, bankers, architects, contractors, and entitlement consultants.   And as a tenant advocate, I have a large stable of them.

In one recent deal, my client was negotiating to purchase a property for development in a , shall we say,  “controversial” submarket from a seller who had been pursuing entitlements to do his own development.  My client maintained what I thought was an overly pessimistic opinion of whether and when the entitlements could be secured.  The parties were at an impasse and talks stalled.  I knew that arguing my case would only have been self-serving.  So I got permission from the seller to have his entitlement consultant meet with my client.  The informed intelligence of this consultant answered my client’s questions, put his mind at ease, and got the negotiations moving forward again.

A good tenant broker will search for clarity…and go to the ends of the Earth to find it.

The New Tenant Creditworthiness Game

Landlords will forever insist on seeing financial statements before finalizing a lease deal with a tenant, whether they are a small business or a publicly traded company.  And they should.  But what does a tenant do if their ship has been tossed – and perhaps badly damaged – in the hurricane of the recent, extended recession?  And, I mean, who amongst us didn’t suffer?

I have represented tenants who, in some instances were looking to downsize for the sake of their very survival.  It was unlikely their financial statements were going to inspire many landlords to spontaneously break into song.  So, did this tenant need to resign themselves to rejection?  Absolutely not.

Landlords suffer a parallel fate as their struggling tenants.  They naturally prefer tenants that have capital reserves that will better insure that their rent will arrive in the mail every month.  But in challenging economic times they are forced to look beyond the numbers, and good brokers can coach their tenant clients how to tell their story in a persuasive way.   It requires taking the time to learn about the tenant’s business and ask some difficult questions to get to the truth.

I recently negotiated a lease for a client – we’ll call him Stuart – who is a prominent, established interior designer for large homes and hotels.  His industry was decimated by the recession and the very fact that he survived at all was a testimonial to his reputation and perseverance.  We presented the landlord with a couple of years of personal tax returns.  This gave the landlord the facts.  They are what they are.  Starting off with honesty is always the best policy.  But what we submitted with the numbers was Stuart’s story: his 30 year history in the business, his impressive resume of clients worldwide, and his nimble resizing of the company to insure its continued viability.  We worked together on the story so it hit what I knew from experience would be a landlord’s hot buttons .  We proceeded to final lease documents without a single question from the landlord.

The facts + a success story that harkens back to better times = the new creditworthiness. 

Tenant Improvement Allowance: It's Not Just How Much But When

How does it feel when you negotiate $100,000 of landlord-funded tenant improvements in your lease, you use $75,000 to get the premises ready for your occupancy, and then find out there isn’t any allowance left a year later when you have to replace the broken down air conditioning unit on the roof?  You just got the shaft, dear tenant…twice!

Most leases are drafted by the landlord and so are skewed heavily in their favor.  Language in the “Work Letter”  – the lease addendum that addresses tenant improvement construction –  typically states that the landlord allowance is for construction and improvements to the premises that relate to the initial space plan and that are performed prior to the lease commencement date; in other words, “use it” for only this work and within this time frame “or lose it”.  Most tenants and many inexperienced or oblivious real estate brokers don’t give this much thought.  The tragedy is that most landlords don’t even pay close attention to this detail; that is, until the tenant surprises them down the road with a request for funding for subsequent improvements, and then they turn the tenant down flat.

I’m giving away a valuable trade secret here, so pay attention!  Try deleting the language that puts time restraints – direct or implied – on the use of tenant improvement dollars provided by the landlord.  It is amazing how infrequently I find landlords rejecting this change to the lease.  The poor soul at the top of this article could have been $25,000 to the better if his broker had done this for him!

There are other improvements that the typical Work Letter states cannot be paid for by the landlord’s tenant improvement allowance, including furniture, fixtures and telecom systems.  These too can be negotiated in your favor by a savvy, experienced broker.

 A good tenant advocate knows that everything in your lease document is negotiable

The Myth of "No Free Rent"

Did you sign a lease only to feel your stomach turn when find out that you left several months of free rent on the table?

Tenants are understandably intimidated by improving market conditions.  Space is actually getting leased up again.  Rents are slowly climbing out of the doldrums of the last recession.   In a few  submarkets they are rocketing up.  Tenants can be intimidated by pronouncements of landlord rep brokers that “we have offers on the table”, “the space won’t last long”, “the premises are being leased ‘as-is’”, and that “the landlord is not offering any rent concessions.”

Those pesky brokers – are they lying?  No – they are just doing their job; that is, to gain the best advantage of improving market conditions for their clients, the building owners.  They are professional salespeople.  And the best ones are great salespeople.  Most tenants are blinded to the fact that they need an advocate who understands the landlord’s position in the market and who isn’t cowed by the pronouncements of their brokers.  Consider: When two professional brokers get down to negotiating a lease, the sales-y rhetoric evaporates and is replaced with the language of the deal.

Let me tell you: in all but the most in-demand micro-markets and neighborhoods, rent concessions are still on the table.  Quality tenants are still highly valued.  There are many concealed flex points in the economics of the lease that allow a good agent to tailor the deal to your specific needs.  

It is wise to have an agent who knows whether that building you really like is really as hot as the owner’s broker would like you to believe it is. 

Making Landlords Love Free Rent

I recently negotiated a lease for a retail tenant with twelve months of free rent up front.  You might be wondering what I slipped into the landlord’s coffee before we started negotiating but that wasn’t the case at all.  The key to negotiating free rent was not to argue the tenant’s financial weakness and need but rather their strength and intelligence. 

As we have all observed, the most vulnerable time for a retail business is in its first couple of years.  In most retail leasing situations, the tenant invests a significant amount of capital into the premises for FF&E, or furniture, fixtures and equipment.  And then there is the investment in marketing and advertising that is absolutely necessary to draw customer traffic to their new location.  As the tenant’s broker, I confidently touted the strength of the client’s business based on its one other established location and convinced the landlord that by allowing the tenant to preserve his operating capital for marketing and promotions, he would be giving them enough “runway” to get the business off to a successful start, greatly improving their chances of enjoying a reliable rent stream over the long term.  It didn’t hurt that this particular landlord had just cancelled a lease for a restaurant tenant that never even opened because they ran out of capital – I researched the situation and worked it to my client’s advantage.

An experienced tenant advocate knows that the objective is not a generic “good deal”, but a deal geared to the tenant’s long term success.